Crude falls as fears of glut intensify

Analyst: At $35 a barrel, service firms could go bust

The collapse of fuel prices reached a new milestone this week: $35 crude oil.

It's a price that cements deeper turmoil in the U.S. oil industry next year, figuring into ongoing corporate investment planning that will determine whether thousands of Houston energy workers will be kept on the payrolls in 2016. At $35 a barrel, even the most efficient U.S. shale drillers can't sell a barrel of oil for a profit.

"Nothing is economic at today's prices," said James West, an analyst at Evercore ISI, a firm that has warned a third or more of the players in land rigs, well stimulation and other types of oil field services could cease to exist next year.

West Texas crude this week fell 11 percent in its largest weekly decline of the year. Traders recoiled after the Organization of Petroleum Exporting Countries signaled it won't restrain its crude production. And the International Energy Agency on Friday warned that lower output outside the Saudi-led cartel isn't enough to ease the global oil glut.

The domestic benchmark on Friday fell $1.11 to a seven-year low of $35.62 a barrel on the New York Mercantile Exchange, capping the worst week since OPEC in November 2014 decided to keep pumping oil into an oversupplied market, letting prices stay low in a bid to drive out higher cost producers in the United States, Canada and elsewhere.

Energy company shares sank 3.4 percent on Friday, causing a broader market reaction as the Standard's & Poor's 500 index lost 39.86 points, or 1.9 percent, to 2,012.37. The Dow Jones industrial average lost 309.5 points, or 1.8 percent, or 17,265.21.

At OPEC's meeting in Vienna last week, oil strategists shrugged off the group's long-standing cap on how much oil it pulls out of the ground, and later reported that Iraqi oil production surged to a record in November.

Demand expected to slow

On Friday, the IEA said global oil demand growth, propelled this year by motorists in the United States, China and India, could slow by a third next year, as emerging market economies slow. And even though producers outside of OPEC are expected to lower daily production by 600,000 barrels, crude inventories around the world are projected to fill up by another 300 million barrels - worsening the glut.

"Storage levels may provide yet another check on reality," the IEA said. "As inventories continue to swell into 2016, there will still be a lot of oil weighing on the market."

Analysts say the price bust will squeeze both the oil producers that staged a revolutionary surge in U.S. energy over the past five years and companies that market equipment and crews.

Since Dec. 4, the Western world's five biggest oil companies - Exxon Mobil Corp., Chevron Corp., Royal Dutch Shell, BP and Total - have lost more than $46 billion in market value. Brent, the international standard, fell $1.80 to $37.93 a barrel on the ICE Futures Europe.

This latest oil-price slump comes as the U.S. oil industry is running out of ways to keep pumping shale oil at high rates through efficiency gains and lower services costs.

West of Evercore estimates the average break-even cost of drilling in North American shale plays has fallen from $65 a barrel before the downturn to around $50 a barrel in recent months.

That's still well above current prices, and the U.S. Energy Information Administration's measure of productivity per rig is flattening out, as technological advances that made drilling rigs more efficient are petering out. Meanwhile, oil field service companies have signaled they aren't stomaching further reductions in service prices, West said.

"We're drilling the best of the best rock right now," West said. "At some point we'll have to move to lesser-quality rock, which will increase the break-even costs."

More spending cuts likely

That could send drilling activity off a cliff.

Oil companies have cut the nation's rig count down by two thirds since last year, with the number of active U.S. rigs averaging 970 in 2015. Wood Mackenzie believes the count could sink by 300 to average 670 next year.

"It could get much worse at this price level," said R.T. Dukes, an analyst at Wood Mackenzie. According to Baker Hughes, U.S. oil companies sidelined 28 oil and gas drilling rigs this week, the steepest decline since September.

As the oil market shows no sign it will recover anytime soon, U.S. oil companies are expected to cut spending by $76 billion from 2014 to 2016 - nearly four times as much as they cut in an oil bust three decades ago, according to ISI Evercore. Cowen & Co. estimates global spending reductions could reach $115 billion next year.

The IEA say growth in global demand for oil has weakened already, declining from a peak of 2.2 million barrels a day in the third quarter to 1.3 million barrels a day more recently. The price of oil is so low, though, that some analysts believe it's unrealistic to believe it could stay at its current level for a long time.

"The $35 to $40 range is kind of a bottom of the market," said Sean Heinroth, a leader in the Energy Practice at global management consulting firm A.T. Kearney. "Even for a temporary time, it's just very hard for the market to stay there for very long. You're putting a lot of production out of the money."

The Associated Press contributed to this story.

Editor's note: This story has been updated to correct the average number of U.S. rigs for the year.

Energy reporter for the Houston Chronicle. Houston native. Former banking and finance reporter.

Prior to joining the Houston Chronicle, Collin Eaton covered the local banking and finance scene at the Houston Business Journal. Before that, he held internships at newspapers in Texas and Washington D.C., generally writing about business, money or higher education. He graduated from the University of Texas at Austin in 2011.